CFA Practice Question

There are 520 practice questions for this study session.

CFA Practice Question

On 1 January 2014 a company enters into a lease agreement to lease a piece of machinery, as the lessor, with the following terms:

Annual lease payment due 31 December: $75,000
Lease term: 6 years
Estimated useful life of the machine: 7 years
Estimated salvage value of the machine: $0
Carrying value (cost) of the leased asset: $300,000
Implied interest rate on lease: 7%
The firm is reasonably assured of the collection of the lease payments.

The total effect on 2014 pre-tax income from this lease, for the lessor, is closest to ______.
A. $32,143
B. $75,000
C. $82,519
Explanation: This is a sales-type lease: the lease period covers more than 75% of the useful life of the asset (6/7=85.7%) and it is on the books at less than the present value of the lease payments ($357,490) (PMT = $75,000, N=6, i=7%). The firm must have acquired or manufactured the asset if it is recorded at less than the present value of the lease payments.

The income in the first year will therefore consist of the gross profit on the sale: (357,490 - 300,000) = 57,490, plus interest revenue from financing the lease: 25,024 (start balance of 357,490 x 7% = 25,024. Total income = 57,490 + 25,024 = 82,514

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